Now assume that CorVIR announces that the firm will undertake a leveraged recapitalisation. In this transaction, CorVIR will take on $250 of new permanent fixed debt and use the proceeds from the debt issue, together with the $150 of cash it already holds, to pay a special dividend to shareholders of $400 (40 cents per share). Assume that the risk of the tax shield of the debt is the same as the risk of the debt. The interest rate on the debt will be 6%.
ii. What will happen to the price of CorVIR’s stock when this recapitalization plan is announced? (6 marks)
iii. Assume now that CorVIR goes ahead with this recapitalization, i.e., raises $250 of debt and pays a dividend of $400. What will be the market values of CorVIR’s equity and debt after this transaction has been completed? What will be the stock price? What is the change in total shareholder value from this transaction (vis-à-vis the case before the transaction was announced)? (7 marks)
iv. Assume now that CorVIR, instead of paying a dividend, uses the $400 (the excess cash plus the proceeds from the debt issue) to repurchase its own shares. How many shares will CorVIR be able to acquire? What will be the stock price of CorVIR after the share buyback? What is the change in shareholder value from this transaction (vis-à-vis the case before the transaction was announced)? (6 marks)

Answer rating: 100% (QA)

Solution ii iii If the company borrows an additional 250 at 6 interest and uses the balance 150 it has to payout dividends to the shareholders this wi... View the full answer